Largely overlooked in the wake of financial regulatory reform, on July 22 two government agencies released reports discussing the regulation of life insurance settlements.
The law firm of Sidley Austin, LLP. noted Monday, August 17, that in response to the growing life settlement market and inconsistent regulation thereof, the Government Accountability Office (GAO) and a Task Force of the Securities and Exchange Commission (SEC) each separately recommended steps be taken to regulate life settlements more consistently and to increase protection for policy owners, investors and intermediaries.
The reports observe that regulation of life settlements is not consistent among states. Notably, the reports also focus on the question of whether and when life settlement investments or transactions should be regulated as securities transactions for purposes of the federal securities laws.
According to the law firm's analysis, while the Task Force Report states that life settlements are treated as "securities" under the securities laws of most states, the reports note that the treatment of life settlements at the federal level is less clear. While variable life policies are recognized as securities, and thus are subject to applicable rules of the SEC and the Financial Industry Regulatory Authority (FINRA), as well as to state securities regulation, courts have reached inconsistent results when presented with questions regarding whether certain investment transactions in non-variable life policies have involved the offer and sale of "securities" under federal securities laws.
SEC Life Settlement Task Force's Response to the Inconsistent Regulation of Life Settlements
According to Sidley Austin, the SEC's Task Force Report made recommendations based on the current inconsistent regulation of life settlements at the state and federal levels, including:
o First, the SEC should consider recommending to Congress that the definition of "security" in the Securities Act of 1933 (the Securities Act), the Securities Exchange Act of 1934 (the Exchange Act) and the Investment Company Act of 1940 (the "Investment Company Act") be amended to include all life settlements (i.e., including a settlement of an individual, non-variable policy, as well as the sale of fractionalized interests in such a policy or policies). The Task Force notes that this would provide for greater consistency in regulation under federal law, as well as provide clear regulatory authority for the SEC and FINRA in policing the life settlement market. In particular, the Task Force Report identifies a number of perceived legal and regulatory benefits that would flow from the treatment of all life settlements as securities, for federal securities law purposes:
- Registration and regulation of life settlement market intermediaries as "broker-dealers" under the Exchange Act.
The Task Force Report concludes that, to the extent life settlements are deemed "securities" for purposes of the Exchange Act, life settlement brokers, providers and producers (sometimes collectively referred to in the report as "market intermediaries") would be required to register as broker-dealers with the SEC and become a member of
at least one SRO -presumably FINRA. Focusing upon the many obligations that broker-dealers owe to their customers (e.g., the duty of best execution and prohibitions against excessive commissions and unsuitable recommendations), the SEC Task Force seems to support this conclusion by emphasizing how both the policy owners/sellers and the policy purchasers/investors would benefit from such protections.
- Offers and sales of life settlements would be subject to registration under the Securities Act, absent an available exemption. The Task Force Report notes that all offers and sales of life settlements would be required to be registered with the SEC pursuant to the Securities Act, absent an available exemption.
- Federal securities law anti-fraud liability; private right of action for misstatements and omissions. The Task Force Report notes that an amendment to the "security" definition under the Securities Act and the Exchange Act would also have the effect of subjecting life settlement transactions to the general anti-fraud provisions of those statutes, including providing a private right of action for misstatements and omissions in connection with the offer and sale of a life settlement.
- Life settlement pools would be subject to potential investment company registration and regulation. Noting that the Investment Company Act defines an "investment company" to include any issuer which "is or holds itself out as" being, or proposing to be engaged primarily "in the business of investing, reinvesting, or trading in securities," the Task Force Report concludes that, if a life settlement is a "security" for Investment Company Act purposes, a pool of life settlements in which interests are issued would become subject to registration and regulation as an investment company, absent an available exemption. The report further notes that investors in the pool would benefit from the comprehensive regulatory framework to which investment companies are subject, including prohibitions and protections regarding the management of the investment company and full and accurate disclosure about the company and its sponsors.
o Second, the Task Force Report recommends that the SEC take additional measures to oversee and ensure that market intermediaries are complying with their current obligations under the federal securities laws and FINRA rules, to the extent the life settlement involves a securities transaction (e.g., suitability obligations owed not only to the individual settling the life insurance policy, but also to "any investors in subsequent transactions associated with that settlement"). The Task Force Report
goes on to note that such SEC and FINRA measures could include examination and enforcement efforts, potential additional or expanded licensing requirements for firm personnel involved in life settlement transactions and investor education efforts.
o Third, the Task Force Report recommends that the SEC monitor the development of the life settlement
securitization market for the purpose of obtaining access to more information about these transactions in the private market. In particular, the report notes that this could be accomplished through requiring that a notice describing any life settlement securitization be filed with the SEC.
o Fourth, the report recommends that the SEC consider encouraging Congress and state legislatures to regulate life expectancy underwriters more consistently, as the underwriters' work affects each transaction's timing and value.
o Fifth, the report states that the SEC should consider instructing its staff to issue a bulletin to investors explaining important information learned by the Task Force in the course of its work (concurrent with the issuance of the Task Force Report, we note that the SEC staff did issue a brief investor bulletin explaining what a life settlement is, the role different market intermediaries generally play, and certain considerations to be considered in determining whether to sell a life insurance policy).
GAO's Response to the Inconsistent Regulation of Life Settlements
The GAO Report provides two main proposals for modernizing the life settlement regulatory system: consistent consumer and investor protection and consistent financial oversight. The GAO concluded that the life settlement market has not achieved these goals to date, as market participants lack useful information and legal protections such as disclosures and sales practice standards. Policy owners receive different protections depending on whether the policy being sold is a variable or non-variable life policy. The GAO Report suggests several solutions, including that the Federal Insurance Office help monitor the insurance industry and bridge gaps in state regulation. The report also encourages measures to be taken to ensure consistent implementation of insurance regulations among state regulators, as the GAO has recommended over the past decade. Finally, the report suggests that Congress consider taking steps to ensure consistent protection of policy owners involved in life settlement transactions, as such transactions currently may lack a clear and comprehensive regulatory scheme.
According to Sidley Austin, in light of the two reports, purchasers and sellers of life insurance policies and other life settlement market participants, especially in the secondary market, should (i) consider whether the securities laws affect their transactions and whether broker/dealer compliance may be necessary and (ii) monitor the federal securities laws and any actions of the SEC, FINRA and other SROs, as well as the Federal Insurance Office, for changes in the regulation of life settlements and life insurance policy investments.